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Brazil’s sectorial funds on a mission to boost innovation

Traditionally, it is the academic sector which has driven research and development in Latin America. As a consequence, innovation has played a minor role in the economic development of a region that is primarily oriented towards commodity exports. The subcontinent accounts for 8% of the global population but just 1.5% of global business investment in research (1).

Business spending on research has progressed in recent years, thanks to strong economic growth and government incentive measures. This progression has been particularly visible in Brazil. Between 2006 and 2010, business investment in research rose from 0.49% to 0.57% of GDP, before falling back to 0.52% in 2012. What caused this inversion of the trend? The UNESCO Science Report offers some insights.

Sectorial funds designed to stimulate innovation

For the past 18 years, the Brazilian government has sought to stimulate innovation through funds which target specific socio-economic sectors. Inova-Agro, for instance, has been channelling funding to the agribusiness sector since 2013.

Inova-Agro is a sectorial fund. It was Brazil which introduced the concept into Latin America in 1999. The government has since established nearly 20 such funds, which have become one of its main sources of research funding. There are sectorial funds for aeronautics, biotechnology, space, hydroresources, information technology, mining, health, oil and natural gas and so on. Not one but two funds target agribusiness, hardly surprising given that Brazil is the second-biggest producer of food after the USA.

Each sectorial fund receives money via taxes levied on specific industrial or service sectors, such as energy utility companies. Here is how a typical sectorial fund works. By law, Brazilian electricity companies must invest a share of their revenue in energy efficiency programmes and contribute to the National Science and Technology Development Fund (FNDCT), which funds research conducted by universities, research institutes and industrial research centres. The law covers both public and private firms. Distribution companies are required to invest 0.20% of their net operating revenue (NOR) in research and development and 0.50% in energy efficiency programmes; a further 0.20% goes to FNDCT. For their part, generation and transmission companies must invest 0.40% of NOR in research and development and contribute 0.40% to FNDCT. The investment in energy efficiency programmes is considered business research expenditure, whereas the funds transferred to FNDCT are considered government funding.

Following in Brazil’s stead

Argentina, Mexico and Uruguay have all followed Brazil’s example. Uruguay launched its own fund for the agro-industry, Innovagro, in 2008. Mexico has created a dozen sectorial funds since 2003. A recent addition is CONACYT-SENER, which promotes innovation in energy efficiency, renewable energy and ‘clean and green’ technologies. In 2013, the Mexican government launched its National Climate Change Strategy with the aim of raising energy efficiency by 5% for the national oil company, PEMEX, increasing the efficiency of transmission and distribution lines by 2% and the thermal efficiency of fuel oil-fired thermoelectric plants by 2%. CONACYT-SENER will be helping to reach these targets.

Some sectorial funds target several economic sectors. For instance, the mission of the Argentine Sectorial Fund (FONARSEC, est. 2009) is to improve competitiveness in all of the following sectors: biotechnology, nanotechnology, information technology, energy, health, agribusiness, social development, environment and climate change.

Two of the Brazilian sectorial funds don’t target any specific industry. The first is the Research and Development Infrastructure Fund, which receives a 20% contribution from each of the other funds to develop academic research infrastructure. The second is the Green–Yellow Fund – a reference to the national flag. It is funded via 33% of the corporations which send funds abroad for technical assistance, royalties and technical services, plus 43% from a progressively decreasing tax exemption awarded to the information technology industry to foster its development.

Sectorial funds to boost the software industry

Argentina, Brazil and Mexico have all designed sectorial funds for their respective software industries, CT-Info in Brazil, FONSOFT in Argentina and PROSOFT in Mexico. These funds provide competitive funding to improve the productivity and innovation capacity of small and medium-sized enterprises. They also encourage university–industry ties.

A 2014 study by the Inter-American Development Bank forecast that, by 2025, Buenos Aires, Montevideo, San José, Córdoba and Santiago would be the five most important poles in Latin America for the development of software and related industries. By that time, business process outsourcing is expected to employ 1.2 million people and generate sales of US$ 18.5 billion in Latin America. Costa Rica currently has the region’s highest percentage of high-tech exports (45% of manufactured goods), largely thanks to the arrival of Intel, Hewlett Packard and IBM in the late 1990s.

Most of Brazil’s sectorial funds have been in place for almost two decades. Why then has innovation not become a motor of economic growth? Why does technology still tend to flow from public research institutions to the private sector? A 2014 report by the Brazilian Materials Research Society offers some insights. It cites the example of researcher Ruben Sinisterra from the Federal University of Minas Gerais, who has been developing drugs to alleviate hypertension. Brazilian universities now have the capacity to develop nanoscale materials for drug delivery, he says, but ‘our domestic pharmaceutical companies don’t have internal capabilities in research and development, so we have to work with them to push new products and processes out to market’.

For the UNESCO Science Report, ‘the lack of internal research capabilities ‘is rooted in the deeply ingrained indifference of businesses and industry towards developing new technologies’. There are some exceptions, of course, such as Embraer, the aircraft manufacturer, Vale, the mining conglomerate and Petrobras, the state oil company. Petrobrás alone is responsible for about 10% of all fixed capital investment in Brazil. Yet, even these corporations share a common characteristic: their staple products are either commodities or goods used by the services industry, like commercial aircraft.

Natura Cosméticos is the exception which confirms the rule. This Brazilian multinational employs a research team of 260 and ploughs 3% of its revenue back into research and development. As a result, two-thirds of revenue from sales in 2013 involved innovative products released in the previous two years. Natura is Brazil’s market leader for personal hygiene products, cosmetics and perfumes, with net annual revenue of R$ 7 billion (circa US$ 2.2 billion) in 2013.

Companies still at the technology acquisition stage

According to a 2014 survey by the UNESCO Institute for Statistics of innovative manufacturing firms in 65 countries (summarized in the UNESCO Science Report), 85% of Brazilian firms are still at the stage of acquiring machinery, equipment and software to enable them to innovate. Among the other BRICS countries (Russian Federation, India, China and South Africa), the percentage varies between 64% and 71%.

Some 17% of Brazilian firms conduct research and development in house, according to the survey, compared to 19% of Russian firms, 35% of Indian firms, 54% of South African firms and 63% of Chinese firms. Brazil is also the BRICS country which outsources research the least (7% of innovative firms), compared to one in ten in India and one in five in the other BRICS. Brazil also trails other Latin American countries. A much higher percentage of firms report in-house research and development in Costa Rica (76%), Argentina (72%), Mexico (43%), El Salvador (42%), Ecuador (35%) and Colombia (22%).

Only 6% of Brazilian manufacturing firms collaborate with universities to develop innovative products and processes, a lower ratio than in Mexico (7%), Colombia (11%), Argentina and Cuba (15%) and, above all, Costa Rica (35%). Brazilian firms are in good company here, though. In most of the 65 countries surveyed, only a minority of firms interact with public research institutions.

A downturn in business innovation

Business innovation not only remains modest. Innovation activity also appears to be ebbing. Firms responding to the Brazilian Institute of Geography and Statistics’ innovation survey in 2013 all reported a drop in innovation activity since 2008. The survey covered all public and private firms in the extractive and transformative sectors, as well as firms in the services sector involving technology. The drop in innovation was most noticeable in telecommunications, both as regards the production of goods (-18.2%) and services (-16.9%).

The larger companies seem to have reduced their innovative activities by the biggest margin between 2008 and 2011. Among companies with 500 or more employees, the share of those involved in developing new products declined from 54.9% to 43.0% over this period. A comparison of IBGE’s innovation surveys over the periods 2004–2008 and 2009–2011 reveals that the 2008 crisis has had a negative impact on the innovative activities of most Brazilian firms. ‘Since 2011, the economic situation in Brazil has further deteriorated, especially in the industrial sector’, observes the report. ‘It can be expected that the next innovation survey [in 2018] will show even lower levels of innovative activity in Brazil’.

Recession not the only explanation

What explains the deteriorating climate for business innovation? The economic slowdown has certainly affected both public and private investment in research. After peaking at 7.5% annual growth in 2010, the economy slowed before dipping into recession in 2015 (-3.7% growth). The government has been forced to adopt austerity measures and is now less able to collect revenue through the sectorial funds, since company profits are down in many quarters. Industrial output declined by 2.8% between November and December 2014 and by 3.2% over the entire year. The UNESCO Science Report predicts that ‘the situation is likely to deteriorate in the short term, as the most recent data indicate that 2014–2015 may turn out to be the worst years in decades for industry, especially for the transformation subsector of the manufacturing industry’.

The economic slowdown was triggered by weaker international commodities markets, coupled with the perverse effects of economic policies designed to fuel consumption. For instance, Petrobrás artificially depressed petrol prices to control inflation between 2011 and 2014, under the influence of the government, its major stockholder. This in turn depressed ethanol prices, making ethanol uneconomic to produce. The ethanol industry was forced to close plants and cut back on its investment in research. Petrobrás’ low pricing policy ended up eating into its own revenue, forcing it to cut back its own investment in oil and gas exploration.

The roots of the problem go deeper, though, than the current recession. The UNESCO Science Report attributes part of the blame for anaemic business innovation to Brazil’s long-standing import substitution policy, which has protected locally produced goods from foreign competition. ‘Why would a local business invest heavily in research and development,’ the report asks, ‘if it is only competing with similar non-innovative companies operating within the same protectionist system?’

‘The consequence of this policy has been a gradual decline in Brazil’s share of global trade in recent decades, especially when it comes to exports of industrial goods’. The trend has even accelerated in the past few years. Between 2004 and 2013, the share of exports dropped from 14.6% to 10.8% of GDP, despite the commodities boom. ‘This trend cannot be explained solely by the unfavourable exchange rate’, asserts the report.

Brazil not only has a declining volume of exports. Basic commodities are also making up a growing proportion. Commodities peaked at 50.8% of all exports in the first half of 2014, up from 29.3% in 2005. Just one-third of goods (34.5%) were manufactured in 2014, a sharp drop from 55.1% in 2005. Within manufactured exports, only 6.8% could be considered high-tech, compared to 41.0% with a low-tech content (up from 36.8% in 2012).

For the UNESCO Science Report, there is another factor at play. Modern industrial development in Brazil is constrained by a lack of modern infrastructure, especially in logistics and electric power generation, along with cumbersome regulations relating to business registration, taxation or bankruptcy, all resulting in a high cost of doing business. This phenomenon has been dubbed the Brazil Cost (Custo Brasil) and it is affecting the ability of Brazilian businesses to compete internationally and pursue innovation.